Tuesday, April 26, 2011

This chart shows two different measures of housing prices, as calculated by the folks at Case Shiller and Radar Logic. Both are showing some softness in pricing in recent months (but they both report prices 2-3 months after the fact), and this appears to be raising concerns in the market about whether housing is entering a new downturn. I'm not as worried about that as I am impressed by how similar the two indices are, by how relatively stable they have been for the past two years, and by the fact that both show the housing price bust to have been of roughly the same magnitude (Case Shiller -31%, Radar Logic -36%).

Let's stipulate, based on this information, that housing prices in major markets across the U.S. have fallen by one-third from the high they reached in 2006. In real terms, that works out to approximately a 40% decline, as shown in the next chart. Over the same period, disposable personal income has risen by about 15%, and 30-yr fixed mortgage rates have fallen from 6.5% to 4.8%. Do the math however you want, that adds up to a gigantic decline in the cost for the average family of buying a home (available measures of housing affordability show that homes have never been so cheap). Maybe housing prices are going to fall another 10%, who knows? But prices have already fallen by several orders of magnitude, and another 10% is not going to make much of a difference in the long run, especially if the Fed succeeds in reflating the economy. A sustained rise in inflation, coupled with what could easily be a housing shortage (given the extremely low level of new home construction relative to new housing formations) could translate into hefty gains for housing prices over the next 5-10 years.

This last chart compares the Case Shiller measure of home prices to Moody's Commercial Property Index. According to this latter measure, commercial real estate has suffered an even greater decline (-45%) than housing prices, with commercial property values having erased all the gains of the past decade. Maybe prices will slip a bit further before this is all over, but there's no denying that there has been a humongous price adjustment. Surely the lion's share of the downward price action is now water under the bridge.

What strikes me most about the action in the real estate market is that it is the opposite of the action in the gold and commodities market, yet real estate, gold, and commodities are all classic inflation hedges. If inflation is heating up and the Fed has trouble reining it in, I have to believe that a rising inflation tide would provide strong support for all tangible asset prices, especially real estate. Of all the things available to an investor who is worried about inflation, commercial real estate looks like the cheapest inflation hedge out there.

Full disclosure: I am long VNQ and a few miscellaneous REITs at the time of this writing.

12 comments:

It is puzzling--why invest in gold (an investment that generates no income), versus real estate, where one might hope for rental income and favorable tax treatment?

Worth noting too is that the commercial real estate collapse is a mirror of the residential real estate collapse, despite the absence of a Fannie or Freddie in the markets. In the commercial sector, they managed to put together an old-fashioned bust without government assistance.

I think Grannis is on to something big. People have gone into gold as it has not recently busted---yet.

The time to invest is when most people do not want to. Sell gold, buy real estate.

Buying gold now is like investing in a bell-bottom pant factory in 1977.

I know--I have some of those pants in the closet yet. I even had a Nehru jacket.

America overbuild on the ideal that everyone could/should own a home. Today many Americans are realizing that house prices don't go up for ever. It is correct that houses have been terrific as inflation hedge, but America is facing changing demographics (Baby boomer anyone), and as such housing requirements are also changing -- out are the 6,000sqf McMansion, in are the 2,000 sqf downtown adjacent condos. Comparing America of the past 40 years with today is to mis the demographic shift. As for commercial real estate, it has done well, but how many more malls will shut down when the freeloaders are finally forced to move out of the McMansion for which they have not paid a cent in mortgage payment for 2 years or more.

Finally, and importantly, many many Americans' FICO score is now below 600 -- they simply cannot buy (and get a mortgage).

I'm beginning to see new development in multi-family. Our clients see a baby-boomlet coming to market the next few years needing housing. I don't think we'll see a lot of new single family homes for quite a while since the kids are realizing that renting isn't so bad and yes, they can't get a mortgage with a lousy job and no credit like they could in 2005.

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